OREANDA-NEWS. Fitch Ratings has affirmed Australia's Long-Term foreign and local currency Issuer Default Ratings (IDR) at 'AAA'. The Outlook is Stable. Australia's senior unsecured foreign and local currency bond ratings are also affirmed at 'AAA'. The Country Ceiling is affirmed at 'AAA', and the Short-Term foreign currency IDR at 'F1+'.

KEY RATING DRIVERS
The affirmation of Australia's sovereign ratings reflects the following factors:

- Australia's highly developed economy, strong governance and effective public and social institutions are consistent with its status as one of the world's most highly-rated sovereigns. A credible policy framework, low public debt and free-floating exchange rate give Australia flexibility to respond to changing economic conditions.

- Real GDP growth is high relative to 'AAA' rated peers, and has been more stable, despite reliance on commodity exports, particularly to China. Fitch forecasts real GDP growth to accelerate to 3.2% in 2016, as a growing output of natural resources more than offsets slowing mining investment. However, the continued fall in the terms of trade has further slowed real income growth. High foreign ownership in the mining industry also curbs the benefits from rising resource exports for the domestic economy. Weak domestic demand, along with cost-cutting in the mining sector, has contributed to a gradual rise in the unemployment rate to 6.3% in February 2015. The Reserve Bank of Australia (RBA) responded with another rate cut - the first since August 2013 - reducing the cash rate to a record low of 2.25%.

- Longer-term, a recovery in the non-mining business sector would help maintain Australia's economic growth. Business confidence remains modest, evident in timid investment intentions. The weaker Australian dollar is expected to help exporting sectors, but it is too early to tell if there are more structural competitiveness issues at work.

- Australia's public debt burden remains lower than 'AAA' peers, at 31.8% of GDP. The general government deficit, combining central and state government balances, was higher than expected in FY14 at 4.5% of GDP because of weak wage growth and lower corporate profits reducing tax receipts. Fitch expects the general government deficit to fall to 3.5% of GDP in FY15. The fiscal consolidation process has been slower than the path set out by the government in the FY2014-15 budget, as not all proposed policies were passed by the Senate. Fitch projects Australia's public debt burden to remain significantly lower than 'AAA' peers in the medium-term even under currently legislated policies. However, the fiscal position is sensitive to a marked deterioration in economic conditions, especially without offsetting policy measures.

- At 153% of disposable income, relatively high levels of debt leave households vulnerable to job losses and higher interest rates. High levels of household savings help households meet debt repayments and maintain consumption, if faced with a negative shock. Nonetheless, a sustained period of economic weakness could erode these savings, leading to defaults. Widespread defaults could also trigger a fall in house prices, which have risen by 20% since 2012 across state capitals. A high proportion of investors may make the housing market more sensitive to changes in risk appetite, although the Australian Prudential Regulatory Authority (APRA) has outlined further steps to reinforce bank lending practices and contain potential systemic risks.

- Australia holds Fitch's highest banking system indicator (BSI) score of 'aa', reflecting sound profitability, strong capital buffers and an improving funding profile. This helps contain negative financial spillovers should there be a sharp fall in house prices. Bank capital ratios do not breach minimum requirements in APRA's 2014 stress scenario, in which house prices fall by 40% and the unemployment rate rises to 13%.

- External finances remain a credit weakness. Net external debt is almost triple the 'AAA' median at 52.2% of GDP in 2014. The current account deficit is also wider than peers, but has narrowed since 2012. A number of factors insulate Australia from short-term funding and exchange rate risks often witnessed in external debt crises. Banks, which make up 60% of external liabilities, are well-hedged against maturity and currency mismatches. The sovereign borrows entirely in local currency, and Australia as a whole has more foreign currency assets than liabilities once hedging is taken into account. However, a change in circumstances that leads to sustained reallocation of capital away from Australia by foreign investors could lead to a more disorderly adjustment.

RATING SENSITIVITIES
The Outlook is Stable, reflecting the fact that Fitch does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could individually, or collectively, result in a downgrade of the ratings include:
- A weak or non-existent recovery in the non-mining sector leading to lower potential growth and employment as the benefits from the mining boom fade, and pressure on public finances.
- A negative external shock, such as a continued rapid decline in the terms of trade following a severe slowdown in China, could lead to a sharp increase in the current account deficit and/or a sustained reallocation of foreign capital.
- A sharp economic downturn, which could also be triggered by external events, could lead to widespread household defaults, banking system distress and a negative impact on public finances.

KEY ASSUMPTIONS
The ratings and outlooks are sensitive to the following assumption:
-The global economy performs broadly in-line with Fitch's Global Economic Outlook, particularly China which has become a key destination for Australian exports. Fitch expects China to grow by 6.8% in 2015.